[US High Interest Rates] 30-year Treasury bond touches 5.2% annually... Expectations of Fed rate hike spread

[US High Interest Rates] 30-year Treasury bond touches 5.2% annually... Expectations of Fed rate hike spread

War-driven high oil prices, concerns over inflation reignition... Structural factors like fiscal deficit

Stock market and economic anxiety... Rising borrowing costs for government, businesses, and households

As ultra-long-term US Treasury yields surge to their highest level in nearly 20 years, anxiety looms over the US stock market and economy.

The main reason for the sharp rise in US Treasury yields, especially long-term bond yields, is the spreading expectation that the Federal Reserve (Fed), the US central bank, will implement an interest rate hike within the year.

The trend of US Treasury yields has emerged as a matter of great concern in global financial markets, given the growing perception that the era of interest rate cuts, a key foundation that has supported the rise in the US stock market and strong economic growth prospects, is coming to an end.

Rising interest rates are pointed to as a risk that will trigger higher borrowing costs and slow down US economic growth.

◇ 30-year US Treasury yield hits 5.2% annually... First time since 2007

On the 19th (local time), the yield on the 30-year US Treasury bond temporarily surged by 7 basis points (1bp = 0.01 percentage point) to 5.20%. This is the first time the 30-year yield has reached 5.20% since July 2007, just before the global financial crisis.

The yield on the 10-year US Treasury bond, a benchmark for global bonds, also rose by 10 basis points to 4.69%, setting a new high since January 2025. The 10-year yield has continued its upward trend after breaking through the psychologically significant 4.5% level on the 15th.

Subsequently, the sharp rise in long-term yields somewhat stabilized, ending the week's trading on the 22nd at 5.06% and 4.56%, respectively.

Will McGough, CIO of Prime Capital, commented, "'Bond Vigilantes' are on the move." Bond vigilantes refer to investors who sell government bonds in protest of fiscal and monetary policies that could lead to inflation.

◇ War-driven high oil prices... "Inflation may not be temporary"

The biggest factor behind the sharp rise in long-term US Treasury yields is the high oil prices stemming from the Iran war.

With the Strait of Hormuz, through which about 20% of the world's crude oil and petroleum products pass, blocked, Brent crude, the international oil price benchmark, surged above $100 per barrel. This is a level 60% higher than before the outbreak of the war and has been sustained.

In particular, as peace negotiations between the US and Iran remain deadlocked, high oil prices are prolonged, raising concerns that this will reignite inflation.

The US Consumer Price Index (CPI) in April rose 3.8% year-on-year, marking the highest increase since May 2023. This is a significant jump from 2.4% in February, just before the war broke out. Core CPI, excluding volatile energy and food, rose 2.8% year-on-year.

The core Personal Consumption Expenditures (PCE) price index, which the Fed uses as a reference for monetary policy, rose 3.2% year-on-year in March. Although it had previously exceeded the Fed's target of 2.0%, the gap has widened further. The 3% range increase is expected to continue in April and May.

The Iran conflict is not the only factor driving interest rate increases.

Analysis suggests that the rise in long-term yields, in particular, is underpinned by structural factors such as inflation exceeding the Fed's target for several years and supply and demand conditions.

In September 2024, the Fed ended its monetary tightening stance after four and a half years by cutting the benchmark interest rate by 0.5 percentage points from 5.25-5.50%. It has since lowered it to the current 3.5-3.75%.

During the same period, the 30-year US Treasury yield moved in the range of 4.0-5.1%. Despite the benchmark rate being cut by 1.75 percentage points, the 30-year yield did not reflect this trend of benchmark rate cuts.

This is because long-term inflation expectations have not fallen to 2%, and the US federal government's fiscal deficit has also continued to worsen. As the volume of federal government bond issuance continues to increase, the 'safe-haven status' of US Treasury bonds has wavered.

◇ Expectations for a Fed rate hike within the year grow

Consequently, expectations that the Fed will further cut interest rates within the year have disappeared, and expectations are spreading that the Fed will move beyond rate freezes to rate hikes.

According to CME FedWatch on the 23rd, the interest rate futures market reflected a 42.5% probability that the Fed would raise rates by 25 basis points by December. A month ago, this probability was 'zero'. Conversely, the probability of a rate freeze decreased from 75.9% a month ago to 32.1%. The probability of a rate cut has disappeared.

The dominant view is that it will not be easy for Kevin Warsh, the incoming Fed chair who took office on the 22nd, to bring about the interest rate cuts desired by President Donald Trump.

The Federal Open Market Committee (FOMC), which determines interest rates, has a total of 12 voting members, including 7 Fed governors, including Chair Warsh, and 5 regional Federal Reserve Bank presidents. It is not a structure where the chair alone can determine interest rates.

The minutes of the FOMC meeting held on the 28th-29th of last month confirmed that a majority of members expressed a hawkish (pro-monetary tightening) stance, indicating that they might have to raise the benchmark interest rate if inflation continues to exceed the target level.

Even Christopher Waller, a Fed governor previously classified as dovish (pro-monetary easing), recently stated in a public lecture that "if inflation does not calm down soon, the possibility of future rate hikes can no longer be ruled out."

Subadra Rajappa, head of US Research at Societe Generale Americas, told Bloomberg that "Warsh is joining the Fed at a time when inflation is rising, and his dovish leanings will be challenged by both the market and his fellow Fed governors."

There are also observations that the Fed has become cautious in evaluating inflation due to high oil prices as "temporary." The Fed had judged inflation in 2021-2022 as a "temporary phenomenon" but later raised rates sharply, leading to much criticism. Chair Warsh was also one of those who criticized this as a "policy error."

◇ Rising borrowing costs risk slowing down US stock market and economy

Rising Treasury yields increase borrowing costs for the US government, businesses, and households.

The ratio of publicly held national debt to US GDP exceeded 100% at the end of the first quarter, reaching 100.2%. This is the first time this ratio has exceeded 100% since immediately after World War II, excluding a temporary surge in the second quarter of 2020 during the COVID-19 pandemic.

The US Congressional Budget Office (CBO) forecasts that the federal government's fiscal deficit as a percentage of GDP will be similar to last year's level of 5.8% this year. It is estimated that the expanded fiscal deficit will not narrow.

Rising Treasury yields increase the federal government's borrowing costs, further exacerbating the fiscal deficit. Last year, the federal government spent $970 billion on net interest costs.

It also pushes up mortgage rates. As of the 18th, the average interest rate on a 30-year fixed-rate mortgage in the US was 6.49%, up 0.04 percentage points from a week ago. This is similar to the level in September last year when the Fed began its three consecutive rate cuts.

Rising mortgage rates are a major factor undermining 'affordability,' which President Trump emphasized ahead of the November midterm elections.

Corporate earnings forecasts, which drive the rise in US stock prices, could also be shaken.

Despite disruptions in the global energy supply chain, upward revisions to S&P 500 earnings forecasts continue, but there are concerns that increased borrowing costs could slow or reverse this trend.

In particular, as big tech companies, which lead economic growth, continue large-scale capital expenditures (CAPEX) for AI infrastructure investment and actively utilize external borrowing such as bond issuance, rising interest rates could lead to higher financing costs and slow down investment.

Small and medium-sized enterprises (SMEs) that have received concentrated loans from the private credit market, where investor concerns have grown, are particularly vulnerable in a rising interest rate environment.

Along with this, the impact of high oil prices already shows signs of slowing US retail sales growth. Retail sales in April increased by 0.5% month-on-month, significantly slowing compared to March (1.6%). Retail sales are an indicator that can gauge changes in consumption, which is the backbone of the US economy.

There are also projections that rising energy prices and borrowing costs could ultimately lead to "demand destruction." This means that economic activity could slow down as consumers reduce spending and businesses cut back on investment.

However, in this case, the Fed would prioritize curbing economic slowdown over curbing inflation, providing conditions for a return to accommodative monetary policy.